Quick Fix Today, Crisis Tomorrow in Obama’s White House

The powers that the Obama administration claimed in order to arrest the financial crisis and mitigate the recession are being used and abused in ways that are undermining the legal and financial stability of the United States. Investors: You are warned.

The first warning was the attempt to snatch Chrysler’s assets away from their rightful owners to pay off administration friends and supporters.

The Obama plan to save Chrysler would have sold Chrysler’s most valuable assets into a new company co-owned by the U. S. and Canadian governments, Fiat and the United Auto Workers (UAW)–with the UAW getting the biggest piece, 55%.

The trouble was: those assets belonged to somebody else. They belonged to the company’s bondholders, who had a legal first claim. Under the administration’s plan, those senior-secured creditors would have received just 29¢ on the dollar.

For a failing company to shuffle assets so as to favor some creditors over others with a stronger claim is a very serious wrong, potentially even a crime. There’s a sound economic reason for this rule of law: Bondholders accept lower returns in good times in exchange for greater security in bad times. Protecting bondholders in bad times ensures that future borrowers will be able to borrow in good times.

In barely four months, Barack Obama has nudged the United States toward a future where legal rights are less secure and contracts more uncertain.

The bondholders squawked. Well–not all the bondholders. Bondholders who had previously taken government bailouts for themselves, via the Troubled Asset Relief Program (TARP), kept quiet. That’s bad enough. It means that these major lenders were breaching their fiduciary duty to their shareholders in order to placate their new masters in Washington.

But what happened to the non-TARP bondholders was even worse. When they squawked, the administration tried to muscle them. Lawyers for the bondholders contend that senior representatives of the Obama administration threatened them. Michael Barone, the ultra-knowledgeable (and normally unflappable) editor of the Almanac of American Politics called it “gangster government.”

The Obama administration denies it threatened anyone. And yet over the past week, one by one, formerly protesting bondholders have abruptly gone silent. Last week, the non-TARP group represented bondholders holding $1-billion in Chrysler bonds. By the end of this week, the group had shrunk to represent only $300-million in bonds. As one commenter observed: that shrinkage suggests that the threats were real.

Then, on Thursday, another alarm sounded.

The state of California faces a desperate fiscal situation. California now has the worst credit rating of any American state. Governor Arnold Schwarzenegger and the Democratic majority legislature have struggled to balance the books, as they are constitutionally obliged to do. They have raised taxes dramatically, but they have also cut some programs. Among the cuts: a $2-an-hour cut in the wages of home health-care workers.

Those workers were unionized, and their union–the Service Employees International Union–carries clout in Obama’s Washington. On Thursday, California state officials told the Los Angeles Times that they had received a warning: The federal government would deny California $6.8-billion in stimulus funds unless the wage cut was rescinded. Since the wage cut will save only about $74-million, the state will have little choice but to surrender.

That missing money will have to be compensated for. Already, California’s budget plans rely overwhelmingly on a mix of accounting tricks (selling future lottery revenues for an up-front payment) and tax increases. Now the state will need more tricks and more tax increases.

And so will the other states, as they too get the message: no pay cuts for unionized workers will be tolerated by Obama’s Washington.

So, result:

In barely four months, Barack Obama has nudged the United States toward a future in which government will be bigger and more assertive–where taxes will be higher and government unions more powerful–where legal rights are less secure and contracts more uncertain.

In California, he is pushing a state toward the fiscal edge in order to favour a union ally. At Chrysler, he has put at risk the security of every contract in the country to please another union.

Meanwhile, his administration is planning changes to the regulation of finance that are likely to leave the United States less dynamic and less innovative in the years ahead–at the same time as taxes rise and educational levels decline. (Already the Educational Testing Service–the people who run America’s SAT exam–predicts a less skilled U. S. workforce in 2030 than today, with literacy rates declining by an average of 5% as unskilled immigration and rising rates of single parenthood take their toll.)

It’s easy to lose sight of these wrong and costly choices in the turmoil of the immediate crisis. But it is these decisions of today that are preparing the crisis of tomorrow.